How to Calculate Your Customer Lifetime Value for Your SaaS Business
We all have fuzzy memories about those complicated algebraic theorems that haunted us in our youth. While most of these theorems tend to…
We all have fuzzy memories about those complicated algebraic theorems that haunted us in our youth. While most of these theorems tend to be forgotten in present-day life, as a SaaS entrepreneur, calculating the customer lifetime value (CLTV) is the only equation you need to remember.
Customer Lifetime Value
Generally, the health of your SaaS business can be determined by two metrics: Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLTV). CLTV refers to the total amount of revenue, on average, you expect to generate per customer during the period over which your product or service will be of value — the entire lifetime of your customer.
For example, if a customer buys a 12 months subscription from SaaS Inc., the amount that he will pay during that period will determine the lifetime value.
The Importance of CLTV
Customer lifetime value is one of the most important metrics in your tool belt if you’re a SaaS business. CLTV helps you focus on the channels that give you the best and most profitable customers. Knowing your CLTV helps you fine-tune your budgeting and forecasting efforts by giving you a good sense of how much revenue you expect to generate.
When discussing, CLTV, the Customer Acquisition Cost (CAC) also come into play. For your SaaS company to be profitable, you need to earn enough revenue per customer to zero out the cost of acquiring that customer. Basically, your SaaS company needs to operate on this formula:
CAC < CLTV
Calculating the CLTV
The simplest way to calculate CLTV is using this formula:
CLTV = Average Revenue Per Account (ARPA) x Average Customer Lifetime
Let’s walk you through an example. Say SaaS Inc. offers three different pricing options for its task management software:
Individual: 20$ / month
Team: $60 / month
Enterprise: $500 / month
SaaS Inc. has a total of 450 customers, 150 on an individual plan, 250 on a team plan, and 50 on an enterprise one. The average customer lifetime varies per price plan:
Average Customer Lifetime:
Individual: 12 months
Team: 18 months
Enterprise: 24 months
With this data, SaaS Inc. can expect to generate $2,013 in revenue per customer:
CLTV = [($20 x 150 x 12) + ($60 x 250 x 18) + ($500 x 50 x 24)] / 450 = $2,013
Accordingly, SaaS Inc. should be spending less than $2,013 to acquire the average customer, otherwise, the business is destined to fail. There is no “right” answer for how much your CLTV should be relative to your CAC, but as a general rule of thumb, SaaS companies shoot for a CLTV that is at least 3X more than their CAC. This mitigates any unexpected variation in acquisition costs or shorter lifetimes without drastically impacting your margins.
Monitoring your CLTV and CAC will help you know the health of your business and therefore know the steps to take to improve profits.